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December 2017

European Central Bank and Bank of England tell same old story

Published: Thursday 28 December 2017

It’s the same old story from Bank of England and European Central Bank...

It’s as you were for interest rates in the United Kingdom and the European Union – and it could be that way for some time.

Following last month’s first increase in a decade, the Bank of England’s Monetary Policy Committee (MPC) voted unanimously in their last meeting 9-0 to maintain the Bank Rate at 0.5%.

The MPC says, “Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent.”

Meanwhile, the Governing Council of the European Central Bank (ECB) left the headline cost of borrowing, its refinancing rate, at 0%, its marginal lending facility at 0.4% and its deposit facility at -0.4%.

The central bank explained, “The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time.”

David Johnson, founding director at Halo Financial, says, “Both results followed market expectations, without major shifts in the exchange rates for the Pound or the Euro.

“The Bank of England (BoE) is still nervously watching the effects of Brexit, but noted the progress made on Article 50 negotiations; it seems that the immediate way ahead for both the BoE and ECB is to proceed with caution.”

The MPC predicted in the November Inflation Report that Gross Domestic Product (GDP) will grow modestly over the next few years. Consumption growth is likely to remain sluggish in the near term before rising, in line with household incomes.

UK net trade has been bolstered by the strong global expansion and the past depreciation of Sterling. Business investment, while affected by uncertainties around Brexit, is projected to continue to grow at a modest pace, supported by strong global demand, high rates of profitability, the low cost of capital and limited spare capacity. Unemployment is set to remain low over the next three years.

UK inflation, which hit 3.1% in November, is expected to initially rise gradually, then decline to near its 2% target in the medium term.

The Governor will be writing an open letter to the Chancellor of the Exchequer, accounting for the overshoot and explaining the MPC’s policy strategy to return inflation to its target level.

“Developments regarding the United Kingdom’s withdrawal from the European Union – and in particular the reaction of households, businesses and asset prices to them – remain the most significant influence on, and source of uncertainty about, the economic outlook,” says the MPC.

“The Committee noted the progress in the Article 50 negotiations between the United Kingdom and the European Union. In such exceptional circumstances, the MPC’s remit specifies that the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.”

It concluded, “The Committee remains of the view that, were the economy to follow the path expected in the November Inflation Report, further modest increases in Bank Rate would be warranted over the next few years, in order to return inflation sustainably to the target. Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent. The Committee will monitor closely the incoming evidence on the evolving economic outlook, including the impact of last month’s increase in Bank Rate, and stands ready to respond to developments as they unfold to ensure a sustainable return of inflation to the 2% target.”

The ECB confirmed the planned reduction in its asset purchase programme (APP) from €60 billion-€30 billion in January 2018. However, it may increase the allocation if warranted. This was reiterated in today’s ECB Economic Bulletin, which indicates a gradual increase in inflation. Eurozone monetary policy will still need to make allowances to get inflation near the target level of 2%, although confidence that this can be reached has improved. Quantitative Easing will therefore continue until the end of September 2018 as planned and this could be extended, if required.

The ECB stated that “an ample degree of monetary stimulus remains necessary for underlying inflation pressures to contribute to build up and support headline inflation developments over the medium term.”

Overall, the Eurozone economy is improving, indicating “a strong pace of economic expansion and a significant improvement in the growth outlook.”
“The report repeats and reiterates points made in the previous announcements from the ECB for the most part,” adds David Johnson, “with little new information likely to affect currency markets at this time.”

The Euro remains steady against Sterling and the US Dollar, with exchange rates still hovering around GBP-EUR 1.12 and EUR-USD 1.19 respectively.